What Moneyball Can Teach You About Investing

I can’t seem to get my kids interested in index investing, but they do share my love of baseball. So last week I took my daughter to see Moneyball, based on Michael Lewis’s book of the same name. She was mostly interested in Brad Pitt, but that didn’t stop me from lecturing her about the lessons the film holds for investors. Bear with me while I explain.

If you’re not familiar with Moneyball, it’s the story of the Oakland Athletics and their maverick general manager, Billy Beane. In the early 2000s, the Athletics had a budget of just $40 million, compared with $126 million for the New York Yankees. The A’s would draft good players and turn them into successful major leaguers, but as soon those players became free agents they would leave for big-market teams. When the film begins, Oakland has just been knocked out of 2001 playoffs and lost three of its top players to clubs with deeper pockets.

Before the 2002 season, Beane decides to shake things up. He realizes he can’t beat the Yankees and other big-budget teams at their own game. So he uses a system of statistical analysis (known as sabermetics) to identify undervalued players. Instead of filling his team with expensive, high-profile stars—who may not be as valuable as they seem—he fills the roster with cheap, little-known players who have underappreciated skills. The A’s go on to win a remarkable 103 games, including a record 20 in a row.

What you know that isn’t so

Sabermetrics revolutionized baseball by debunking a lot of conventional wisdom. It revealed that many traditional statistics (batting average, runs batted in, fielding percentage, a pitcher’s win-loss record) actually tell you little about a player’s value. It found that that time-honoured strategies like the sacrifice bunt and the stolen base, despite their intuitive appeal, turn out to have a low probability of success. Even the idea of the clutch hitter—a player who consistently comes up with big hits in key situations—was revealed as a myth.

Not that everyone agrees with this assessment, of course. There’s a wonderful scene in the film where a veteran scout angrily tells Beane that he’s relying too much on stats and not enough on intangibles. “You’ve got a guy in there with an economics degree from Yale, and a guy out here with 29 years of baseball experience,” the scout fumes. “And you’re listening to the wrong one.”

What does this have to do with investing?

Moneyball reminded me that investing, like baseball, is dominated by old-school thinking that doesn’t hold up to rigorous scrutiny. Traditional statistics that tell you nothing useful? I’d put pretty much all technical analysis in that category. Strategies that sound compelling but rarely succeed? That’s the definition of active management. The financial equivalent of baseball’s mythical clutch hitter is the mutual fund manager with the hot hand.

Then there are the money managers who overvalue their knowledge and experience, like the old scout who criticized Billy Beane. Stock pickers continue to believe they can consistently identify market-beating stocks with methods Benjamin Graham pioneered in the 1930s. The irony is that Graham himself recognized this is futile in an efficient market. “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities,” he said in a 1976 interview. “This was a rewarding activity, say, 40 years ago, when our textbook Graham and Dodd was first published; but the situation has changed a great deal since then.”

There’s one more parallel here. Statistics can tell you a lot about both baseball and financial markets, but in both cases the outcomes are never certain. Sometimes an ill-conceived, highly risky play will succeed and make you look like a genius—whether that’s stealing home or making a big bet on a single stock. Other times you’ll do the right thing and suffer short-term failure. But overall, in sports and investing, long-term success comes from putting the odds in your favour. As Michael Lewis writes, that is “the art of winning an unfair game.”

9 Comments

gene
October 13, 2011 at 12:39 am

I really like this post. I’ve always been interested in the book “Moneyball” but never read it. Now that there’s a movie, I’ll probably somehow never see that also, but this gives a good summary of the salient points and how it can relate to our investment pursuits.

I wouldn’t put too much credence in the idea that the market is efficient, at least not all the time. We do see bubbles periodically as well as periods of deep value. It’s still a good point that it’s not always easy to profit from these situations by applying market timing, but I would say the market is usually efficient, but not always.

Anyway, thanks again for the post. It was really well thought out and well written. I tipped you 50 cents on tiptheweb.org. I don’t know how long it takes for the money to get to you, but you should go there and claim your website and poke around a bit. Seems like a really innovative way to give bloggers a (very) little extra kudos for their work.

Michel
October 13, 2011 at 6:32 am

Interesting article! I find that you got me really interested in the film, especially at this time of the year (baseball playoffs). My interest lately has been with the Buffett approach in relation with the long term indexing and/or “good solid dividend paying stocks forever”. In light of your analysis in this article, where would you say Buffett fits the best. Is he with the veteran scout yelling at Beane?

@gene: It’s true that markets are not perfectly efficient, but as you say, the inefficiencies are usually short-lived and it is extremely difficult to profit from the consistently. Thanks for the tip!

@Michel: I would never insult Warren Buffett by calling him an old-school thinker. It’s more accurate to say he’s an outlier, like Babe Ruth. Ruth used to hit more home runs than entire teams—he was in a category all by himself. I’m more critical of the folksy wisdom about “buying good companies you understand.” By the way, Buffett is on record several times suggesting that investors should use index funds rather than trying to pick stocks.

Bob
October 13, 2011 at 2:53 pm

Can you pls provide the link to Dan Solin’s next article after “Six Deadly Investment Myths”. The next article was to suggest what to invest in for geater returns.

Thanks

Greg
October 13, 2011 at 2:56 pm

I have not seen the movie yet but did read the book when it first came out and became fascinated with the concept. While Moneyball deals with sabermetrics, it is really about money value – how do I get the most bang for the buck. At the time, that meant adopting sabermetrics over the gut instinct of a scout. The stats used by Billy recognized the most valuable but least expensive commodities in player evaluation. Fast forward 8+ years and the rich teams now all have stats guys and lots of scouts, and began to value some of the most important stats such on-base percentage. That has caused players with the top on-base percentages to be some of the highest paid players around. So, some of the stats adopted by Billy that revolutionized how teams were built are no longer able to provide the most bang for the buck or the best value. Those stats may be part of sabermetrics but they are no longer “Moneyball” traits (i.e. they no longer identify the most valuable but least expensive commodities). Highschool athletic players and top notch defence (no doubt with stats behind them) are now being identified as the most valuable but least expensive traits when drafting players. Moneyball is not about the stats but all about finding undervalued evaluation tools and using those to build a team on the cheap.

From an article last year Beane actually compares his theory to investing and you won’t like it:

“It’s all about evaluating skills and putting a price on them,” Beane says. “Thirty years ago, stockbrokers used to buy stock strictly by feel. Let’s put it this way: Anyone in the game with a 401(k) has a choice. They can choose a fund manager who manages their retirement by gut instinct, or one who chooses by research and analysis. I know which way I’d choose.”

@Greg: You’re right, it’s not a perfect analogy: Beane has more in common with a value investor than with a Couch Potato. :) But I found the most interesting part of his story was the clash between old and new ideas. I don’t disagree with Beane’s overall point about fund managers. However, he seems to imply that research and analysis means stock picking. I would counter that if he looks at the academic research he would see that it overwhelmingly favours passive investing.

You are right that the original Moneyball ideas, once they were recognized by other GMs, got baked into the salaries that players commanded. It seems baseball’s free agent market is also efficient!

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Dale
October 20, 2011 at 7:10 am

Great parallel. Sabremetrics removes emotion. And loved the film. Took my son to see it – he’s a top AAA player (little league) and left-handed pitcher. Hits a ton too. After the film I asked him if he thought he’d get one of those offers slipped across the table. He just might.

Loved the writing by sorkin and partner.

“How can you not be romantic about baseball?”

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